Thinking ahead about restructuring before you need it
Restructuring is typically not on the tip of the tongues of CEO’s that are running profitable companies.
However, we can take a page from restructuring to address the current market and position many companies find themselves in today.
“Sometimes the best offense is a good defense.”
Many companies have taken advantage of lower debt rates historically, more liberal covenants required by lenders and the ubiquity of available capital in recent years. They are now starting to feel the effects of rising rates, slower growth and tighter oan covenants.
These changing conditions especially in combination can be extremely challenging and even the kiss of death for many companies. Reviewing your options and seeking counsel and even a new playbook may be imperative before it’s too late to act.
Consider the current environment:
1. Interest rates have risen, making debt and debt service more expensive for companies.
2. Deductibility of interest expenses per the 2017 tax law changes further restrict interest deductibility for highly leveraged companies, thus increasing tax liabilities and potentially reducing available cash.
3. Inflation across various costs: labor, commodity pricing, etc. Costs in many industries are outpacing price increases.
4. Potentially slower growth due to recession.
5. Technological or other changes in market conditions pressure gross margins or causing higher use of cash (cap-ex).
It’s no wonder many otherwise great companies’ profits are under pressure in the current landscape.
Smart CEO’s and CFO’s are thinking about their capital stack and overall corporate finance in the face of rising costs, and potentially lower cash flows. Add to this the prospect of a general slowdown over the coming 12 months, this review is becoming more critical.
While the more drastic aspects of corporate restructuring (bankruptcy or 363 sales for example) are not appropriate for healthy companies, we can craft a strategy to refinance debt and consider bringing in new investment (minority recapitalization). Many should consider selling a majority or all of the company to the highest bidder while the going is still good for the ultimate de-risking or diversification play.
Which Levers to Pull
Refinance Debt – While there is little we can do to affect interest rates in the current environment when it comes to corporate debt we can think about “term” and “structure” more than rate. Should your existing loans be refinanced to create more cash and lower debt service? Will that additional cash flow allow you to invest in technology to be more competitive or efficient? Can we turn the dials a bit to help overall corporate objectives?
Other Creative tactical considerations:
- Interest-only payments
- PIK the interest to the end of the note.
- Consider a Cash Flow loan with flexible payments.
- Cash Flow leasing vs. fixed-term PP&E Loans.
Minority Recapitalization – Many company owners (Boomers in particular) are reaching a stage in their life where de-risking and diversifying are more desirable than leveraging their balance sheet for growth. These CEOs are considering selling a portion of their company to reduce debt by taking in outside equity. Even those without much debt are finding this strategy a great way to reinvest in a particular area of their company to be more competitive or catapult into a new product line. Some are using outside equity to fund M&A and “buy” advantages in the market.
- Replace debt with equity to de-risk
- Still maintain operating/voting control
- Minority stake valuations are lower than control investment reducing dilution for sellers
- Can provide cash to support growth
- Cash for M&A (Inorganic Growth)
- Helps seller diversify by “Taking chips off the table”
Majority Recapitalization or 100% sale – Practically speaking, sometimes “you gotta know when to hold ‘em and know when to fold them”. For those who do not have the desire to ride out or make the changes necessary to weather the next recession, lack long-term passion for their legacy business, or are ready for an encore career – now may be the time to sell.
Consider these market factors:
- Still plenty of Dry Powder on corporate balance sheets and Private Equity funds.
- Relatively low growth environment pushing more companies to buy vs build.
- Little margin / multiple compression for A+ companies.
If you are a middle Market CEO or CFO now is a great time for a thoughtful strategic review of your capital stack and corporate finance objectives in coordination with your evolving exit planning work. For those holding significant debt or are underperforming their peers, we suggest you heed this advice now before you find your choices limited in a tightening credit market and rising rate environment.
The most frequent mistake of high-growth CEOs focused on taking advantage of the current market climate is failing to protect their backside.
M&A Axiom: Value is created and measured not only in current earnings but to the degree the future earnings (and cash-flows) are de-risked.
By Craig Dickens, CDI Global Partner